Margin trading and leverage.trading belong together and are both in the same area of trading but they have two distinctly different meanings. Margin is the initial capital you deposit in your account and leverage is the added buying power that you broker multiplies to your positions.
When you trade any financial asset with credit you need margin capital to access those funds. The more leverage you use the less of your margin capital you have to add and the more margin you add the less extra purchasing power you need to use.
Key takeaways:
- The two main differences between leverage and margin are that the margin is your own capital and leverage is the borrowed money you receive from your broker.
- Margin and leverage are not the same thing, however, they are both used together to create a boosted position in the forex market.
What is the difference between leverage and margin?
The difference between margin and leverage is that margin is your own money and leverage is the borrowed funds that you receive from your broker.
You need margin to be able to access credit much the same way that you need a collateral downpayment on a mortgage to be able to receive your loan.
They then go hand-in-hand when you later open a leveraged position.
Your margin capital also always acts as risk capital and when you lose money it is withdrawn from your margin account balance.
Once the position is closed out your margin balance is returned to your account and the credit line is returned to the broker.
All profits and losses are calculated on the total position value where both values are combined.
Once you see the difference between them it becomes easy to understand the relationship and how you can use margin to choose between different leverage ratios.
For example, if you have an account size of $100 and you want to trade with $1000 you need to use 1:10 leverage.
However, if you have a $200 account size you only need to use 5 times more purchasing power.
The more margin capital you put up the less credit is required to reach your position size.
Margin ratios are also explained in terms of how many percent of a position is margin capital.
In our previous example of the $100 account size, you need a 10% margin to trade with $1000.
If you take this $100 account size and trade with a 1% margin you could access 100 times more capital and trade with a $10.000 position size.
Related: 100x leverage explained
Margin explained
Margin is the initial capital that you invest to trade with leverage and is the full amount of your account.
Trading with borrowed funds means that you borrow money and to access this “loan” of cash you need to put down an initial downpayment.
This downpayment is the margin that is also seen as your risk capital and it is always your margin that is lost when your trade goes against you.
It is also what you earn when you make a profitable trade and all your gains are added to your account balance as margin. Whenever you make a profit you increase your margin and whenever you lose it is deducted.
Another way to see margin is as your collateral capital and works the same way as when you borrow money to buy a house, a car, or to start a business. Every loan has an initial collateral payment that you are required to pay to receive a loan.
The collateral ratio varies depending on how big your loan is and there is also an interest to be paid back to the lender.
Most brokers who offer leverage.trading in different financial assets will add leverage fees to compensate and these fees are always withdrawn from your margin account. Usually, the fee is calculated for all positions kept overnight and paid at midnight.
Leverage Explained
Compared to margin, credit is the borrowed funds you receive after you deposit your margin capital and is the added buying power to your positions.
You are free to choose your level, or ratio, of borrowed funds before you open the position.
For example, if you choose a leverage ratio of 1:5 you will get access to five times your initial deposit.
Let’s say that your initial margin deposit was $500 and if you choose to open a position with a 1:5 ratio, your maximum position size would be 5 x $500 = $2500.
In this case, your trading margin requirement to use this ratio was only 20% which means that you only had to put down 20% of your capital to receive the credit to open your position.
Leverage is a double-edged sword in the sense that it can be used to increase profits significantly due to the increased purchasing power but it also increases the magnitude of your losses.
It will benefit any good trader who is an expert in entering the market at the right time and using the proper risk management tools such as stop-loss or other protections from downside movement.
Many traders wonder, can you lose all your money with margin trading? While the answer is yes, you can, there are many ways to protect your downside.
In today’s markets, borrowing credit is easily accessible and the ratios keep increasing to match the demand of high-risk traders.
Also, read our guide on why brokers provide leverage if you want to dig deeper into the topic.
Initial margin capital vs leverage
Depending on how much capital you decide to deposit in your investment account you can calculate how much margin you need to use to reach a certain position size.
Let’s say that you want to trade $10.000 lots and you deposit $5000 as your initial margin capital you only need to use a 1:2 leverage.
Your initial margin capital is what your account is built of and it is what sets the scene for your trading activities.
If your initial deposit is big enough you don’t need to use a lot of borrowed capital to trade big positions which reduces the overall risks of leverage.trading.
To calculate your full position size you always use your initial margin capital multiplied by the margin ratio.
For example, if your initial deposit is $1000 and you are going to trade with a ratio of 1:20 your maximum position size is $20.000. See the calculation below:
$1000 x 20 = $20.000.
Use our leverage.trading calculator to learn how much initial margin capital is required for each position.
Leverage ratios
The leverage ratio you choose has a direct impact on how much margin you need to add to your position.
For example, if you choose a high ratio such as 1:50 you only need to add 2% of your margin capital to the position.
This significantly increases the risk of your position but it reduces the overall margin invested. If you choose to use a lower ratio, your margin requirement increases.
Let’s say that you are going to use a 5 times credit, then you will need 20% of your margin capital to open a position.
Below is a table that explains further the concept of these ratios.
I have chosen to add the position size to the left and show you how much of your margin capital you need to put down for each leverage ratio.
Account size | 1:2 | 1:5 | 1:15 | 1:30 | 1:60 |
$200 | 50% = $100 | 20% = $40 | 7.5% = $15 | 3.75% = $7.5 | 1.875% = $3.75 |
$1200 | 50% = $600 | 20% = $240 | 7.5% = $90 | 3.75% = $45 | 1.875% = $22.5 |
$5000 | 50% = $2500 | 20% = $1000 | 7.5% = $375 | 3.75% = $187.5 | 1.875% = $93.75 |
As you can see, the higher your credit ratio is the lower your margin requirement becomes.
For example, to open a position of $5000 with a 1:2 ratio you need $2500 but if you use a ratio of 1:60 you only need $93.75.
When you use ratios over 1:100 it is considered a highly leveraged position and your risk is increased significantly.
Our guide on strategies for high leverage.trading will help you out if you are a complete beginner.
Questions asked by other traders
No, they are not, although they are connected. Margin is the initial investment that allows you to access margin. When you deposit money in a brokerage account you essentially add margin to access borrowed capital. Borrowed money is the added buying power that your broker adds to your position.
When you open an account with a stockbroker and invest $200 to trade 20x credit, your initial deposit acts as a margin and the borrowed funds you receive is the credit line. There is a difference between short-term trading and long term leveraged investing.
Margin is the capital that you put down as collateral and leverage is the added capital you get from your broker depending on the ratio you choose. When trading any market you always have to add some of your own money (margin capital) to get access to borrowed funds.